Monday, December 19, 2016

Gold Is Nowhere Near Ready To Shine

Market-timing investors ride a downward ‘slope of hope.’

“Gold will have to decline even further before contrarian analysis flashes a buy signal.”

So began my month-ago column on gold-market sentiment, and it remains just as true today as then — if not more so.

That’s because the average short-term gold timer has responded to declining prices for the yellow metal GCG7, -0.22% over the last month by becoming more bullish. That’s just the opposite of how they typically respond to declines, and suggests that there is a strong underlying current of optimism in the gold-timing community.

That’s a bad sign, according to contrarian analysis. Tradeable bottoms usually are accompanied by widespread skepticism and despair rather than bottom-fishing.

Consider the average recommended gold exposure level among several dozen short-term gold timers I monitor on a daily basis (as measured by the Hulbert Gold Newsletter Sentiment Index, or HGNSI). This average currently stands at minus 4.0%, versus a reading of minus 18.0% a month ago when gold bullion stood at just shy of $1,200 an ounce.

In other words, in the wake of a $60+ drop in gold’s price, the average gold timer has increased his exposure level by 14 percentage points.

That means we are even further away than we were a month ago to the sentiment levels that would lead contrarians to issue a buy signal. As you can see from the chart above, those necessary levels are lower than minus 30%.

How much further must gold decline in order to cause the HGNSI to drop to those low levels? It’s impossible to know, since it depends on how the gold-timing community behaves. A month ago, for example, we easily could have expected that a $60+ drop in gold’s price would have led the necessary number of gold timers to throw in the towel — thereby causing the HGNSI to drop to well-below minus 30%.

It didn’t, of course, so you might conclude that at even bigger drop is necessary to do the trick. But it could also be that an extended trading period for gold would lead the gold timers to give up in frustration.

Fortunately, contrarians don’t need to predict what it will take, or when it will happen. Instead, they can let the situation unfold on a day-to-day basis. If the HGNSI drops significantly in the next several days, for example, then a contrarian buy signal would be forthcoming relatively soon.

Such a signal could take a lot longer to appear if the gold-timing community persists in its relative optimism.